Peter Hoskin, Economic Research Officer at Reform, criticises the Government’s simplistic equation of investment with outcome.

The key fiscal lesson of the past decade is that increased public
spending does not necessarily yield an improvement in public services.
After all, whilst real terms spending in the UK increased by 43 per
cent between 1997 and 2007, public sector yardsticks such as GCSE
results and cancer mortality rates have remained stuck on pre-97
trends. However, there have been some improvements, almost exclusively
in those areas in which reform has been introduced.

Given this, and given that we are entering a future of sparse public
money, the true litmus test of the Comprehensive Spending
Review / Pre-Budget Report (CSR 2007) is of whether it progresses the
reform agenda. Unfortunately, it is a test that the document fails –
spending once again trumps reform.
This conclusion may not be apparent at first glance, with CSR 2007
appearing to show some degree of public spending restraint. For
example, it announces that public spending growth for the next three
years will be around 2.1 per cent per annum – the lowest level of
growth for some eight years. Furthermore, this level of growth will
catalyse a steady reduction in the public spending-to-GDP ratio, from
around 42.4 per cent next year to 42.0 per cent in 2010. When we recall
that public spending has risen by five percentage points of GDP since
1999, all this might be considered a tentative step in the right
direction.

However, international comparison reveals that the restraint of CSR 2007 is not drastic enough. A spending-to-GDP ratio of 42 per cent is still significantly above the 35 per cent achieved in highly-competitive countries such as Ireland and Australia, and rivals that estimated for “big state” countries such as Germany.

The OECD has recently recommended that – in order to meet the challenges of the future, such as population ageing – countries urgently need to embark upon fiscal consolidation via reductions in public spending. In this respect, then, the UK lags far behind other nations. Indeed, figures in yesterday’s document reveal that the UK might be slackening its finances, rather than consolidating them – net borrowing will be £38.0 billion in 2007-08 (£4.3 billion higher than the estimate of Budget 2007) and £36 billion in 2008-09 (£6 billion higher than the estimate of Budget 2007).

Crucially – and ominously – the drivers for future UK public spending growth remain. The first few months of Gordon Brown’s government have ushered in numerous, large spending commitments – from a £3 billion increase in spending on affordable housing to a pledge that a further £15 billion will be invested in British railways. These commitments will eventually prompt spending to erupt beyond any 2.1 per cent growth constraint. The tightening of the belt may only be temporary.

Aside from the numbers, Government rhetoric is also discouraging. In his speech yesterday, Alistair Darling frequently equated increased spending with improved outcomes, and he made little mention of reform. This perfectly encapsulates the first few months of the new Government; months which have seen a general retreat from reform and an increase in central control. Nowhere is this centralising bent more apparent than in the interim report of Lord Darzi’s NHS review, which proposed both increased regulation to tackle hospital infection and extra spending on new primary care centres according to central decisions. Many of these proposals were yesterday adopted as formal Government policy.

By contrast, George Osborne’s response to Mr Darling included the word “reform” numerous times, as well as the key proclamation:

“Britain needs a Government which prepares us for the new economic revolution by freeing our economy, reforming public services and putting us on the path to lower taxes.”

Yet, whilst this sentiment is certainly welcome, previous Conservative announcements may impede the party’s ability to deliver on Mr Osborne’s words. In particular, the Conservatives have pledged to match the Labour spending limits, as set out in yesterday’s CSR. Quite apart from the problems with these limits noted above, a commitment to high spending will not allow much space for a sustained programme of tax reduction, especially given that the global credit squeeze is widely expected to restrict growth rates in the real economy. In short, “sharing the proceeds of growth” may prove difficult when there is not much growth to go around.

All of which means that the two main parties need to readjust their approaches to public spending. In a period of economic slowdown, the first priority of policymakers should be to drastically rein in spending by deriving better value from public services. Not only can widespread reform deliver this better value, but it would also catalyse improvements in public sector performance and create fiscal space for tax reductions. In the end, reform is the one sure route to the low taxation and the high quality education system which are prerequisites for UK success in the coming decade.